IRS Changes Position on Sale of Unallocated ESOP Shares

One of the most troubling Internal Revenue Service (IRS) rulings on employee stock ownership plans (ESOPs) has been reversed. Under the old rules, if an ESOP sold unallocated shares, any amounts left over from the sale proceeds after the debt on those shares had been paid could be allocated to employee accounts. However, these allocations would count as "annual additions" and could not exceed the section 415 limits that restrict individual allocations to not more than 25% of pay (including allocations from other plan contributions). Since the amounts involved often would exceed these limits, trustees were put in a quandary. The IRS provided no guidance on what to do with the excess amounts, but any decision, such as transferring it to a successor plan at the new employer, would harm the interests of at least some participants. Basically, the IRS said this was not its problem.

In a technical assistance memorandum whose release data was not available at this writing, the IRS regained its senses and reversed this untenable position. It ruled that the excess amounts from the sale should be treated as earnings, and thus not be subject to the 415 limits. While a TAM does not have the force of regulations, the facts and circumstances of the company case that prompted the ruling are "plain vanilla" enough to suggest that this will be the approach in the future.